Propane and Propane Accessories

Lately, I’ve been on the prowl for new high-yield ideas.

Although I hate dividend cuts, once a company goes that route, it can have a nice financial tailwind.

That’s because this action liberates cash that can be used to shore up the balance sheet or invest in new growth.

While investors punish prospective dividend cutters as the moment of reckoning nears, they can later reward them if the move turned out to be positive from an operational or financial standpoint.

And some MLPs already have such high payouts that their yields are still in the double digits even after making the dreaded cut.

That’s the case right now with Suburban Propane Partners LP (NYSE: SPH). Its units yield 10.2% on a forward basis, even though it slashed its payout by 32% in October.

The problem is that there have now been two consecutive warmer-than-average winters. And that’s weighed on cash flows for propane MLPs.

Because propane is mainly used for heating, distribution of the fuel is a highly seasonal business that generates the vast majority of cash flows during fall and winter.

Normally, this low-risk enterprise allows operators to take on more debt than companies in other industries. And propane MLPs also tend to offer fairly high payouts.

But it’s hard to support all these obligations when the weather won’t cooperate. And while this winter is supposed to be colder than last year, there’s no guarantee it will be.

That’s left propane MLPs and their investors weighing whether to bet on a binary outcome—a cold winter or another warm one.

Rather than risk an existential crisis, SPH decided to cut its payout now instead of counting on the weather gods to come through.

The MLP had been significantly under-earning its distribution for more than a year-and-a-half.

The situation was sufficiently worrisome that the company even negotiated with lenders to ease the covenants on its credit revolver through late next year.

These short-term debt facilities are like a company’s credit card. Losing such crucial liquidity can force companies into bankruptcy.

Lenders agreed to let SPH’s net debt to EBITDA (earnings before interest, taxation, depreciation, and amortization) rise as high as 5.95 times through June 2018, then step down to 5.75 times in the third quarter, before reverting to 5.5 times thereafter.

The 32% distribution cut frees up nearly $70 million annually. Management plans to use this cash to reduce debt and support growth initiatives.

Net debt to EBITDA stood at 5.2 times at the end of the third quarter, and SPH is targeting leverage under 4.0 times.

The $1.4 billion MLP currently has about $1.3 billion in total debt on its balance sheet.

Of course, the easiest way for leverage to improve is for cash-flow generation to return to what it was when it didn’t feel like spring in the middle of winter.

Regardless, SPH has a reasonable buffer on its borrowing capacity for another nine months.

However, the MLP has yet to recover from the sour sentiment leading up to its cut. Its units have been severely punished and still trade at a long-term low.

Consequently, in addition to sporting a tempting yield, SPH is also one of the cheapest MLPs on the market. Right now, SPH’s units trade at a price-to-EBITDA ratio of just 5.9 times compared to a sector average of 8.7.

And seasonality aside, the propane distribution business is generally less risky than other midstream operations.

The question is whether it makes sense to stretch a bit further for yield in this case. There are, after all, other attractive options among propane MLPs.

SPH’s distribution cut has deferred its existential concerns for at least another winter. But if this winter ends up being warmer than average too, then another distribution cut could be in the offing.

There is a lower-risk play that offers an equally enticing yield, though one that’s below the psychologically significant 10% threshold.

AmeriGas Partners LP (NYSE: APU), the largest propane distributor in the U.S., currently yields 8.4%.

And while AmeriGas is facing some of the same challenges as SPH, it’s in a much stronger financial position.

Further, its sponsor, UGI Corp. (NYSE: UGI) recently made a move that’s got AmeriGas covered even if the next two winters are warmer than average.

The two companies recently agreed to a $225 million standby equity commitment that AmeriGas can tap if it needs to do so. Right now, it has no plans to use the facility, but, hey, you never know.

AmeriGas definitely offers the right balance of risk and reward. But there’s something awfully tempting about a 10.2% yield.

Still, let’s see if the weather cooperates first.

Stock Talk

Robert 111

Robert 111

Are APU and UGI recommendations or not. Your discussions are not that helpful if you, an expert, are not ready to commit.

Why not wait until you have made a decision and then give us the paragraphs of info. I’m getting the feeling that you are filling space and not seriously committed to this newsletter

Ari Charney

Ari Charney

Hi Robert,

This article was mainly about SPH, which is on my Income Millionaire watch list. As a moderately aggressive, double-digit high yielder at the time, I thought it would be of interest to subscribers, even if I wasn’t quite ready to pull the trigger myself.

And some subscribers may have fewer qualms about certain things that give me pause. After all, they are free to buy the stock if it fulfills their own parameters, regardless of my more stringent conditions.

APU is a recommendation in our sister service, Utility Forecaster, where it currently rates a buy below $46. I merely mentioned UGI because it’s APU’s sponsor.

Most of the time, our weekly updates cover economic, policy, or sector-specific news that pertains to our holdings before drilling down into a couple of updates about our existing recommendations.

But if there’s not a lot of news from our holdings in a given week, I will occasionally use that as an opportunity to write about one of the stocks on my watch list. However, it’s not something I plan on doing often.

Best regards,

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